Chapter 7: Types of Economic Regulation
116. As discussed in Chapter 4, markets where there is little or no competition or prospect of competition (or where a firm or firms have significant market power) may need to be subject to some form of economic regulation in order to provide for the long term benefit of consumers. There are several types of economic regulation. The most common are:
- Regulatory control (e.g. price/revenue caps and quality requirements) – the regulator sets prices and related terms and conditions, including quality standards.
- Thresholds – the regulator sets thresholds, which if breached, could lead to an inquiry into whether a firm should be put under a regulatory control regime. Electricity lines businesses are currently subject to such a regime under Part 4A of the Commerce Act. New Zealand appears to be unique in providing for such a regime.
- Commercial negotiation with mandatory dispute resolution – the supplier and its customers are encouraged to negotiate a commercial outcome, with the facility for the regulator or an arbitrator to make binding decisions on supply terms and conditions if the parties fail to reach a commercial agreement.
- Information disclosure/price monitoring – the regulator requires regulated firms to disclose extensive information to facilitate price monitoring, with an implicit threat of more direct intervention if firms' behaviour becomes unacceptable.
117. Recognising that regulation is far from costless, it is desirable to ensure that the most cost-effective type of regulation is implemented in a given circumstance. Note that this does not necessarily imply that the least intrusive type of regulation should be introduced first. Moreover, it is necessary to ensure that the process for considering and assessing different types of regulatory intervention is cost-effective and efficient.
Current Provisions
The Commerce Act provides for regulatory control under Part 4 and a thresholds regime for electricity lines businesses under Part 4A. Implementation powers for control are provided under Part 5.
It is not clear whether the Act allows the Commerce Commission to make recommendations on alternative forms of regulation. The absence of a clear mandate is inefficient, since the Commission is likely to have the expertise and knowledge to make informed recommendations on whether an alternative form of regulation has the potential to offer a more favourable trade-off between costs and benefits than control under Part 5.
It is clear however, that there are no powers in the Act to implement other lighter-handed forms of regulation. Thus, if an alternative regulation was found to offer net benefits compared to control (or no regulation), implementation powers would need to be provided for through legislative amendment.
7.1 Should "lighter-handed" regulatory options be included in the Commerce Act?
118. Different forms of regulation, while aiming to achieve similar policy objectives, are likely to have different implications for the economy, regulated businesses and the regulator. That is, they differ in their ability to constrain market power, degree of regulatory intrusiveness (and therefore business compliance costs), ability to offer predictability and certainty, and regulatory costs. The Commerce Act currently provides for regulatory control under Part 4 and a thresholds regime for electricity lines businesses under Part 4A. This section considers whether "lighter-handed" types of regulation should also be provided for in the Commerce Act.
Negotiation/arbitration
119. As noted, negotiation/arbitration involves encouraging the supplier and its customers to negotiate a commercial outcome, with a backstop power for the regulator or an arbitrator to make binding decisions if the parties fail to reach a commercial agreement.
120. Relative to control, negotiation/arbitration is likely to be less intrusive for businesses and less costly to the regulator (as it is only used if commercial negotiations fail). However, negotiation/arbitration will likely only be suitable where an entity with market power is dealing with a small number of relatively large customers (such as retailers and major users). In such a situation, customers may have sufficient bargaining power to negotiate their own terms with the supplier, and transaction costs and information asymmetry are likely to be less of an issue. The prospects for success are likely to be enhanced if information disclosure is also available.
121. The backstop powers under this option would provide for the regulator to undertake, or require, binding arbitration if the parties are unable to agree. Careful design of this provision would be needed. (The Telecommunications Act uses a negotiate/arbitrate/determination regime, and considerable experience in design of such regimes is now available). It is important to allow sufficient time for parties to reach commercial agreement, while discouraging gaming behaviour and incentivising the parties to reach agreement. Arbitration also needs to be expert, cost-effective and timely. Powers for the regulator to set pricing principles may also be helpful.
122. The Ministry proposes that the scope of the economic regulation provisions be expanded to allow for a negotiation/arbitration regime. Regulation or rule making powers would need to be provided in the Act to empower the Commerce Commission to develop, consult on and recommend to the Minister the process and relevant principles (including pricing principles and input methodologies) for implementing a negotiate/arbitrate regime. The Minister would have an ability to accept/reject or refer back such a recommendation.
Information disclosure/price monitoring
123. An information disclosure regime is generally less intrusive for regulated businesses and incurs less administrative expense than, for example, direct price/revenue control. However, given that information disclosure on its own has no direct consequence and is subject to considerable time lags, it may not be very effective at constraining any significant abuses of market power. Furthermore, this approach may lead to regulatory uncertainty for regulated business and their investors, as disclosure by itself may be seen as a temporary arrangement, with the possibility of much tougher regulation being introduced at any given time.
124. Information disclosure also involves cost (although less than other forms of economic regulation) and detailed rules need to be put in place and enforced to ensure that the disclosed information is informative, robust and comparable over time and between firms.
125. The Ministry proposes that powers to put in place an information disclosure/price monitoring regime be provided under the Commerce Act. Information disclosure has the potential to be suitable in situations where direct intervention is not justified, but some form of regulation and watching brief is required to temper the potential abuse of market power and to provide information on when more direct intervention may be required.
7.2 Criteria for imposing more light-handed regulation
126. Chapter 6 discusses the criteria that need to be satisfied prior to regulation being imposed. There is, however, a question of whether the same criteria are appropriate for more "light-handed" types of regulation. For example, there is a question of whether both the competition and efficiency/net acquirers' benefit criteria should need to be passed to impose information disclosure. And, if so, should the same rigour be applied to calculations in determining whether the criteria are passed?
127. Chapter 6 proposes to make the "competition test" tougher than the current test. One view is that satisfying only the (tougher) competition criterion should be sufficient to allow the introduction of light-handed regulation, such as information disclosure. According to this view, sectors where there is on-going market power should be subject to light-handed regulation to allow monitoring of prices and performance and provide consumers with on-going assurance that advantage is not being taken of that market power.
128. An alternative view is that the efficiency/net acquirers' benefit test is central to the question of whether or not any type of regulation should be considered.
129. However, one potential problem with requiring consideration of the efficiency/net acquirers' benefit test, is that it has come to be taken as requiring comprehensive quantitative cost-benefit analysis. As noted earlier, New Zealand appears to be unique in applying such analysis to the question of whether to regulate sectors with natural monopoly characteristics. While the Ministry does not propose any change to this requirement when considering whether control may be introduced, there is a question as to the practicality and value of requiring comprehensive quantitative cost-benefit analysis with respect to light-handed regulation, such as information disclosure. Such analysis can be very resource-intensive and time-consuming. An option therefore would be to require only qualitative assessments of costs and benefits to determine whether information disclosure (and potentially negotiation/arbitration) should be imposed. Submissions are sought on this point.
Questions for submitters: Chapter 7
Q1. Do you agree that it is desirable to widen the scope of the Commerce Act by providing for regulatory options other than control, specifically:
- negotiation/arbitration; and
- price monitoring/information disclosure?
Q2. Do you consider that specific, easier tests should be provided to determine whether lighter-handed types of regulation, such as information disclosure, may be imposed, such as:
- meeting the competition criteria only; or
- requiring qualitative (rather than quantitative) cost-benefit analysis?
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